India relaxes its stance on contract R&D centres, to relief of multinationals

July 04, 2013

Rules imposed on contract R&D centres earlier this year by the Indian government have been relaxed and amended after it transpired foreign multinational companies would incur a tax liability for outsourcing more of their R&D activities to India.

Circular 2, released on March 26, has been withdrawn because it gave taxpayers the impression there was a hierarchy to the methods listed in section 92c of the Income Tax Act and that the profit split method is the most appropriate method for transfer pricing in R&D centres. This goes against the Indian transfer pricing regulations.

Circular 3, also released on March 26, has been amended and reissued as Circular 6 because it seemed vague about the conditions for deciding whether a development centre is a contract R&D service provider with insignificant risks.

“The circular [3] now provides that the countries which will be considered as low-tax would be notified and also elaborated that conceptualisation and design of the product and providing strategic direction and framework would be considered as economically significant functions,” said Manisha Gupta of Deloitte.

However, Gupta said the amended Circular 3 could have gone further in its guidance.

“Different industries, such as biotech, pharma, IT etcetera, have varied nature of functions to be undertaken in their value-chain. The amended definition is brief and could have provided more clarity to [the transfer pricing officer (TPO)] and the taxpayers on what the Revenue would construe as economically significant functions for different industries.”

In addition to these clarifications, the government also made public, for the first time, a report made by the Rangachary Committee to review taxation of development centres and the IT sector, dated September 12 2012, which formed the basis for the initial release of Circulars 2 and 3.

“ Although, the Rangachary Committee had recommended that the conditions be looked at cumulatively, the [Central Board of Direct Taxes] has rightfully relaxed the parameters to provide that the conditions are only guidelines to the TPO and the TPO is required to take a decision based on the totality of facts and circumstances of the case,” said Samir Gandhi of Deloitte. “Having said that, the Circular now gives a lot of discretion to the field level officers and one will have to see how they adopt it in practice.”